When it comes to understanding cryptocurrencies like Bitcoin, it’s not only about buying, holding, and trading, but also about compliance with the IRS. That’s right—if you made any gains from Bitcoin in the past year, you owe taxes.
Bitcoin and other cryptocurrencies are fairly new, so even those who have invested in them for several years might not quite have a handle on the legal issues surrounding them. The IRS came forth in 2014 to issue guidelines stating that cryptocurrency must be treated like property for federal income tax purposes.
Here’s what you need to know about when bitcoin taxes must be paid, how to calculate bitcoin taxes, and how to file the right way.
- Bitcoin is a virtual currency that does not exist in any physical format.
- Investors may use Bitcoin as currency or hold it as an investment to sell as the price rises.
- You are required by law to report cryptocurrency capital gains, including those from Bitcoin, on your federal income tax returns and pay any applicable taxes.
- The IRS has grown more explicit in its guidance regarding Bitcoin taxes over the past few years and is actively seeking those who may have avoided paying Bitcoin taxes in the past.
- Some cryptocurrency exchanges have begun to issue a Form 1099-K for those with more than $20,000 in crypto transactions.
- Currently, questions about cryptocurrency capital gains are placed prominently on Form 1040 so they’re hard to ignore or miss.
How do bitcoin taxes work?
For the purposes of federal income tax calculation, you need to treat your cryptocurrency gains as you would a piece of property.
If you have bought, sold, used, or traded any bitcoin or any other virtual currency, you should do some careful calculations to determine whether you owe any taxes on that cryptocurrency.
U.S. individuals must report gains and losses on cryptocurrency holdings, not just material holdings. The IRS provides IRS Notice 2014-21 to explain how virtual currency taxes work. Essentially, since crypto is treated as property, capital gains taxes apply.
One crucial first step in simplifying your Bitcoin taxes is to keep meticulous records of all cryptocurrency transactions. This will help you know the cost basis and gains on Bitcoin when tax time arrives.
Keep in mind that since cryptocurrency is fairly new and plenty of people don’t fully understand it, you may be better off consulting with a tax professional who knows cryptocurrency. That person can provide specific tax guidance to help you avoid errors in your calculations of Bitcoin taxes.
How to calculate bitcoin taxes
Let’s take a peek at a few key phrases related to cryptocurrency and taxes:
- Taxable events: Transactions or uses of virtual currency that result in gains
- Capital gains: Any money gained through transactions (e.g. when you sell bitcoin for a higher price than you paid for it)
- Form 8949: IRS form for reconciling amounts of capital gains and losses
- Form 1099-MISC: IRS form for reporting rewards/fees income from staking
- Cost basis: The fair market value of a cryptocurrency when you acquired it
When you sit down to figure out your Bitcoin taxes, you’ll want to have a grasp on what the IRS considers a “taxable event” regarding cryptocurrency. Here are a few activities with your virtual currency that would likely be taxable events:
- Selling cryptocurrency for cash (resulting in realized gains)
- Using mined or purchased cryptocurrency to pay for goods or services
- Converting cryptocurrency (using one virtual currency to pay for a different virtual currency)
- Receiving mined cryptocurrency
- Receiving virtual currency as payment (this counts as ordinary income)
- Receiving crypto rewards
The general rule of thumb is that if you realize any gains from your cryptocurrency, you could owe taxes on them (as is true with physical property). So, if you simply have Bitcoin or other virtual currency sitting in your cryptocurrency wallet but don’t sell or use it, you haven’t realized any gains.
Some other non-taxable events include donating cryptocurrency to charity and transferring cryptocurrency between your own crypto wallets.
You may also have the issue of a hard fork. According to the IRS, a hard fork is when a cryptocurrency undergoes a major protocol change. If you don’t receive a new cryptocurrency, this does not create taxable income. But if a hard fork is followed by an airdrop and you receive a new cryptocurrency, that does count as taxable income.
As with other property, losses on your crypto can be used to offset gains, up to $3,000 per year. Plus, you can carry over additional losses to future years.
Capital gains range from a 10-37% tax rate for short-term gains, or gains on crypto held for a year or less.
For individuals, long-term capital gains (for assets held more than a year before selling) are taxed at:
- 0% if you make $40,400 or less
- 15% for income between $40,401–$445,850
- 20% for income above $445,851
During or after your calculations, it’s smart to touch base with a tax professional. Taxes get complicated even before factoring virtual currency into the equation, so don’t hesitate to let a professional help you through the maze. Peace of mind is worth its weight in Bitcoin.
Can I avoid bitcoin taxes?
The short answer: No.
So what about the long answer? If you’ve gotten out of it in the past, it’s time to change that. The U.S. government is cracking down on both individual cryptocurrency holders and the exchanges that manage their accounts. You should not attempt to avoid paying your legally required amount of taxes on Bitcoin.
Take a lesson from the actions the IRS has taken over the past several years to recoup lost tax revenue:
- In 2019, the IRS announced it was sending letters to 10,000 people who potentially owed back taxes on cryptocurrency.
- Similar letters of warning to potential virtual currency tax evaders went out in 2020 and are expected to repeat in 2021.
- The 2022 White House budget proposal will have new crypto reporting requirements built in.
- Cryptocurrency exchanges are now being ordered to provide information that will assist the IRS in locating people who have avoided paying taxes on Bitcoin and other cryptocurrencies.
Uncle Sam certainly doesn’t want to lose out on Bitcoin tax revenue. IRS chief Charles Rettig said that cryptocurrency taxes make up a chunk of the estimated trillion dollars that are lost annually due to unpaid taxes.
How to file bitcoin taxes
Once you’ve calculated any taxes you may owe on bitcoin or other virtual currency, it’s time to file them along with your federal income tax return. Several crypto-focused tax software programs exist to help taxpayers make sense of their cryptocurrency tax requirements. CoinTracker even integrates with TurboTax to simplify that process, and other crypto tax software may integrate with other regular tax software.
Once you’ve used Form 8949 to reconcile capital gains and losses for the year, simply report them on your IRS Form 1040 using Schedule D.
Exploring and investing in crypto can be fun. Paying taxes on your Bitcoin? Not so much.
The reality is that you do have to file and pay taxes on Bitcoin and all other virtual currencies you hold. Use the IRS guidance published on its website to guide you through the specific details of your crypto earnings. If your returns are high enough, consider using a crypto-focused tax preparation software or hiring a Bitcoin tax professional to cover your assets.